The Federal Reserve said on Wednesday it was raising its benchmark interest rate by three-quarters of a percentage point, the sharpest increase since 1994, as it seeks to combat the biggest rise in U.S. inflation in four decades.
The US central bank has set its rate target in the range of 1.5 to 1.75%. The federal funds rate, which controls how much banks pay to borrow money from each other, affects borrowing costs for consumers and businesses.
The Fed had previously suggested it would likely raise rates by half a percentage point at each of its three meetings this year, but recent signs thatspurred policymakers to act more aggressively to slow economic growth in an attempt to tame prices.
“The labor market is extremely tight and inflation is very high,” Federal Reserve Chairman Jerome Powell said at a news conference on Wednesday.
“My colleagues and I are aware that high inflation poses significant difficulties, especially for those least able to afford the higher costs of essentials like food, housing and transportation,” he said.
Powell said the Fed will likely continue to raise rates, in increments of 0.5% or 0.75%, as it tries to contain demand for labor. Cooling labor markets should dampen wage growth, helping to mute price increases, Powell said.
Impact on Ukraine
In raising interest rates, the Federal Open Markets Committee noted in its policy statement that Russia’s war in Ukraine and ongoing supply chain struggles are “creating additional upward pressure on inflation and are weighing on economic activity.” global”. Furthermore, “COVID-related lockdowns in China are likely to exacerbate supply chain disruptions,” the committee said.
The Fed expects inflation to fade gradually this year, albeit less slowly than previously predicted. Policymakers project that personal consumption spending – the Fed’s preferred indicator of inflation – will fall to 5.2% by year-end, 2.6% in 2023 and 2.2% in 2024.
Stocks rose on the news. The S&P 500 gained 1.3% after the announcement, while the blue-chip Dow rose 1% and the high-tech Nasdaq added 2.3%.
“The Federal Reserve did not disappoint market expectations, responding to last week’s positive surprise in consumer prices and rising inflation expectations, which suggested more aggressive action,” said Rubeela Farooqi, chief economist at High Frequency Economics, in report.
The Fed has quickly shifted gears this year from propelling the economy through the pandemic to trying to stem a rise in consumer prices, which have been rising at the fastest pace since the 1980s.
However, the Fed’s decision to raise interest rates poses risks for the job market, consumers and businesses. Much higher borrowing costs could dampen economic growth and cause a “hard landing” or even a serious recession. That would increase unemployment and hurt wage growth as millions of US workers are reeling from the economic meltdown caused by the pandemic.
More broadly, the wages of most workers have been stagnant for decades, leading to growing inequality and political instability. Using monetary policy to contain wage increases, while potentially controlling inflation, can do little to silence the rising demand that is primarily responsible for the rise in inflation.
Powell said on Wednesday that reducing the number of jobs, which would weaken the leverage workers have to demand better wages, would help stabilize the economy.
“You have two job openings, essentially, for every person who is actively looking for a job, and that has led to an imbalance in job negotiations,” he said.
While wages are not the main reason prices rose last year, “in the future, they will be extremely important,” he added, saying, “We have to restore price stability. It is the basis of the economy. Without it, economy won’t work. People’s wages will be consumed.”
The economy has slowed sharply this year,amid a slump in US exports and reduced federal spending. The Fed expects the country’s gross domestic product to grow 1.7% this year and into 2023 as higher interest rates act as a brake on economic activity.
Economic growth remains solid, with unemployment near a 50-year low of 3.6% and companies continuing to hire. But the highest inflation since 1981 is hitting households hard and causing consumer spending to shrink, with the government reporting retail sales fell in May. The 0.3% drop, the first since December, is a sign that higher gas prices may be forcing consumers to spend less on other purchases.
Last week, a University of Michigan opinion poll found that Americans’ expectations for future inflation are rising, a worrying sign for the Fed because expectations could become self-fulfilling.
This is a developing story. The Associated Press contributed reporting.